Sieren’s China: The rapid rise of the yuan

The US dollar as the world’s top reserve currency was never going to be replaced from one day to the next. But it might happen sooner than many would have expected.

The weak euro and US debt are inadvertently conspiring to turn the yuan into a top reserve currency faster than Beijing would perhaps like, says DW columnist Frank Sieren.

Largely unnoticed, the yuan – as the Chinese renminbi is commonly known – has already overtaken Canada’s and Australia’s dollar to rank fifth for use in global payments, behind the Japanese yen, Britain’s pound sterling, the euro and the US dollar – according to the Society for Worldwide Interbank Financial Telecommunication (SWIFT), through which the financial world conducts its business operations.

Even so, for the time being, the yuan is used in just 2 percent of global payments. The US dollar is used in 44 percent. A vast difference. But it seems less imposing when one considers the astonishing leap in the yuan’s market share. The yuan climbed 100 percent as a payments currency in 2014, while others managed just 4 percent. Over 25 percent of China’s trade dealings with the world are conducted in yuan.

The biggest obstacle to its continued rise, however, is the fact that it is not free-floating, but rather pegged to the US dollar.

Should the yuan be free-floating?

If Beijing would like to see the yuan become the world’s most widely held reserve currency, it will need to introduce an economic and financial framework to make it free-floating. This is the goal that Prime Minister Li Keqiang is currently pursuing with more diligence than ever.

But Beijing is faced with a dilemma: on the one hand, the world’s top reserve currency is necessarily a free-floating one. But on the other hand, is it also one that is vulnerable to the power games played by the international financial industry, which could instrumentalize a free-floating yuan against the Chinese government to either buy or sell the currency on a large scale.

The world economic crisis in 2008/2009 demonstrated all too clearly why it might be a good idea to avoid reliance on international financial markets. The yuan might well never break free of the US dollar. But the day might come when it rivals its value. It might even replace it as the world’s top reserve currency, just as the US dollar replaced pound sterling in the mid-20th century.

Traditionally, the world’s top reserve currency belongs to the world’s biggest economy. In terms of purchasing power, China has already overtaken the US, but a comparison of the two countries’ per capita incomes ($6,800 in China; $53,000 in the US) reveals that the yuan still has a lot of catching up to do.

Relaxing controls

But Beijing is still ensuring that the yuan continues to advance in leaps and bounds. In 2009 it began allowing international trade dealings to be conducted in renminbi. The Chinese central bank also began allowing foreign banks to conduct RMB business, albeit according to highly stringent rules. RMB business saw a major boost in the financial hub of Hong Kong in 2010, with companies permitted to issue renminbi-denominated bonds, dubbed “dim sum bonds.”

McDonald’s Corp.’s yuan bond sale was the first by a foreign company in Hong Kong and secured the company fresh funds for its business in China.

High interest rates made these dim sum bonds especially attractive to investors – so attractive that the value of Hong Kong’s yuan savings pool shot up from 315 billion to 944 billion in just five years.

Many German companies have also raised capital this way. As of July 2013, Chinese investors have been allowed to transfer their yuan abroad, while as of November 2014, Chinese units of multinationals can do the same in the form of intercompany loans, with a new cross-border liquidity management model allowing companies to transfer local currency automatically across borders.

China has also awarded nine stock markets, including London‘s and Frankfurt’s, licenses to clear and settle payments in yuan – giving Asian investors direct access to European capital markets. In future, companies in a further 11 cities will be able to pay for goods in yuan.

Giving the US dollar and euro a run for their money

The yuan is also shaping up nicely in the new Shanghai free trade zone, the testing place for a free-floating version. Ultimately, China would like to create a yuan zone, not just in Shanghai but across Asia, a process that it currently being facilitated by the weak value of its competitors.

With the Federal Reserve printing too many greenbacks, the strength of the US dollar is increasingly a shadow of what it was. For years, China has been the US’s main creditor. And the euro, meanwhile, is threatened by the economic gulf between Europe’s north and south.

Both currencies will most likely continue struggling in the next few years and that’s good news for the yuan. But it also creates uncertainties for China and puts Beijing under pressure to bring the yuan out of the shadows of other global currencies sooner than it might have planned.

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